What will a potential tax increase mean for U.S. dividend stocks?

U.S companies are already getting nervous about the prospect of a big jump in dividend tax rates that could go into effect early next year. Without an agreement in Congress to extend an existing tax break set to expire in January, the tax rate on U.S. dividend paying stocks could jump from the current 15% to 44.6%.

All of that, naturally, is leading investors to ask whether dividend stocks in the United States could become a lot less attractive after the new year. Luckily, Myles Zyblock, chief institutional strategist at RBC Dominion Securities, has looked into the issue.

Mr. Zyblock looked at what happened to dividend stocks historically when a higher dividend tax rate came into effect. He examined a large basket of equities and looked at performance six months before a hike, and six months after. The conclusion? “It’s a coin toss,” says Mr. Zyblock in a note to clients.

For instance, the highest yielding group of stocks (which represents the top 20% of the group) outperformed in only four out of the seven years that the U.S. government hiked the dividend tax rate. The next highest yield group of stocks outperformed in only three of four instances. Meanwhile, the lowest yielding group outperformed in five out of seven instances.

Of course, if a tax hike does occur in 2013, it will be larger than any tax hike since 1950. That means history might not necessarily be a good indicator of performance this time around. But Mr. Zyblock says that given the relatively poor performance of high yielding stocks in past tax hikes, it would be wise for investors to take note.

“The high payout ratio, low growth, higher-yielding equities which have shown strong price gains over the past few quarters are at greatest relative risk within the dividend-paying universe,” he said.

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